December 28, 2010

Five years ago, Matthew R. Simmons and I bet $5,000. It was a wager about the future of energy supplies — a Malthusian pessimist versus a Cornucopian optimist — and now the day of reckoning is nigh: Jan. 1, 2011.

The bet was occasioned by a cover article in August 2005 in The New York Times Magazine titled “The Breaking Point.” It featured predictions of soaring oil prices from Mr. Simmons, who was a member of the Council on Foreign Relations, the head of a Houston investment bank specializing in the energy industry, and the author of “Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy.”

I called Mr. Simmons to discuss a bet. To his credit — and unlike some other Malthusians — he was eager to back his predictions with cash. He expected the price of oil, then about $65 a barrel, to more than triple in the next five years, even after adjusting for inflation. He offered to bet $5,000 that the average price of oil over the course of 2010 would be at least $200 a barrel in 2005 dollars.

I certainly would have bet against Mr. Simmons, as well, but he didn't offer to bet me.

My suspicion at the time was that Simmons was, more or less, writing a $5,000 check postdated January 1, 2011 to buy his book publicity right now on the NYT op-ed page. That might explain why he didn't haggle and try to split the difference with Tierney, such as putting the win-lose line halfway between $65 and $200, the way a real betting man trying to make money would. But a public bet that the price of oil would be, say, $132.50 or higher would have been kind of a boring story. In contrast, a man confident enough to put $5,000 on the round number of $200 is a man who is acting like he might know something, and thus you'd better buy his book to find out what it is.

All that said, I fully expect to see gasoline pump prices of $5 to $10 per gallon. (I'm just not telling you when.)

41 comments:

Anonymous
said...

I vote "sincere" rather than "cynical." Simmons already had his NYT windfall publicity when he made the bet, and the bet didn't get much publicity at the time.

Also, if Israel hadn't successfully sabotaged the Iranian nuclear program, and had to use more conventional means, leading to Persian Gulf retaliation, that $200/barrel price might well have been reached.

On the other hand, the real reason that Simmons made a dumb bet is that if he really thought the price of oil would be $200 in 2011, he could have gotten much better than 1:1 odds for his $5000 investment by buying appropriately priced futures. If nothing else, he could have bought $5000 worth of oil in 2005 and ended up with a profit despite "losing" the bet.

You could have bought a futures contract to buy oil at $65 five years out and made serious money at any price over $70 or so. The futures contract is very cheap in that direction. If he'd wanted, the author could have put down millions of dollars at more favorable terms on any price over $70.

Just the fact of the high strike price shows that this bet was made for publicity, monetizing the writer's position at the NYT. I hope there is an ethics panel at the paper that requires bets like this be paid off to a charity.

The book "Twilight in the Desert" is quite a read. However, you need some background in petroleum geology to fully understand it.

Two notable points come to mind. First, Mr. Tierney may have some difficulty collecting on his bet. Matt Simmons died a few months ago.

Second, the world economy crashed back in 2008. Without the downturn $200 oil might well be a reality. Indeed, some observers (notably James Hamilton) argue that the 2008 crash was in part triggered by the oil price runup.

Of course, there was a famous, public bet between Paul Ehrlich (author of the 'Population Bomb') and Julian Simon (an economics professor). Ehrlich famously wagered that a basket of oil and commodities would rise heavily in price during a set time period (in the 70s and 80s, I believe), Simon bet otherwise. Julian Simon won the bet to Ehrlich's considerable embarrassment. - I believe that Ehrlich was on the right track, though.Basically what had happened is that the slump and deflation that occurred throughout the 70s and 80s (GDP was stagnant throughout that period, unemployment was massive)had killed demand.The slump was of course engendered by the two oil shocks of 1973 and 1980 during which, in simple terms, the west simply could not afford to pay its oil bill and thus deflated their economies to 'cope'. All that really has changed in the past 30 years is the emergence of China as an industrial super power and hyper exporter.It seems to be unaffected by commodity price constraints.

"Indeed, some observers (notably James Hamilton) argue that the 2008 crash was in part triggered by the oil price runup."

Yeah, Stephen Leeb wrote a book in *2004* called The Oil Factor, about the phenomenon, which we saw play out in 2008.

His book explains his "oil indicator" for the stock market.

In a nutshell, an increased price of oil is the main driver of consumer price increases. Peak Oil-driven steady increases in the oil price of, say, 20% or less a year are very good for gold, and Wall Street can handle it, usually seeing steady increases in the DJIA, with Big Oil cos. being the leaders. Main Street also can struggle along okay with it, more or less, assuming they get COLA raises every year.

But when there's a price *spike,* that is, oil doubles in price in a year or less, as happened in 2008, it leads to deflation / recession because the sudden spike, uncushioned by cost-of-living-adjustments, crushes the ability of Americans to fill the SUV and do the long commute to work.

Since American consumers are so indebted, as soon as they can't afford to commute, they will quickly lose their jobs and houses, and houses in the hinterlands like Victorville turn into Section 8 ghettos, unable to find new buyers willing to accept that long commute. The stock market will crash as a general response to the sudden loss of credit from failing banks who have too many "nonperforming assets" (aka mortgage defaults). So you need to sell your stocks anytime you see that doubling of the oil price in one year.

So Stephen Leeb told us 6 years ago that under the Peak Oil paradigm, the general economic environment for the foreseeable future will be generally inflation, puntuated by deflationary periods of a year or 2 each.

In 1919 David White of the U.S. Geological Survey (USGS) predicted that world oil production would peak in nine years. And in 1943 the Standard Oil geologist Wallace Pratt calculated that the world would ultimately produce 600 billion barrels of oil. (In fact, more than 1 trillion barrels of oil had been pumped by 2006.)

During the 1970s, the Club of Rome report The Limits to Growth projected that, assuming consumption remained flat, all known oil reserves would be entirely consumed in just 31 years. With exponential growth in consumption, it added, all the known oil reserves would be consumed in 20 years.

~~~~~~~~~~~~~~~~~~~~~~~~~

* In May 1920, the U.S. Geological Survey announced that the world’s total endowment of oil amounted to 60 billion barrels.

* In 1950, geologists estimated the world’s total oil endowment at around 600 billion barrels.

* From 1970 through 1990, their estimates increased to between 1,500 and 2,000 billion barrels.

* In 1994, the U.S. Geological Survey raised the estimate to 2,400 billion barrels, and their most recent estimate (2000) was of a 3,000-billion-barrel endowment.

~~~~~~~~~~~~~~~~~~~~~~~

In 1919 the director of the U.S. Bureau of Mines predicted that "within the next two to five years the oil fields of this country will reach their maximum production, and from that time on we will face an ever-increasing decline."

That same year, National Geographic magazine predicted that oil shales in Colorado and Utah would be exploited to produce oil, because the demand for oil could not be met by existing production.

In January 1920, Dr. George Otis Smith, Director of the United States Geological Survey, in commenting upon our oil supply stated: "The position of the United States in regard to oil can best be characterized as precarious."

In May 1920, Dr. Smith said: "Americans will have to depend on foreign sources or use less oil, or perhaps both.

In 1920, David White, of the United States Geological Survey, stated: "On the whole, therefore, we must expect that, unless our consumption is checked, we shall by 1925 be dependent on foreign oil fields to the extent of 150,000,000 barrels and possibly as much as 200,000,000 of crude each year, except insofar as the situation may at that time, perhaps, be helped to a slight extent by shale oil. Add to this probability that within 5 years--perhaps 3 years only--our domestic production will begin to fall off with increasing rapidity, due to the exhaustion of our reserves"

If the economy hadn't tanked the worst it has tanked since the Great Depression (something that practically no economist predicted), oil would be price a lot higher than it is today. It would probably be closer to $200 than to $65.

So Tierney won this bet for the wrong reason. He was betting that new supplies would keep prices low, and not that there would be a massive recession inhibiting demand.

Yes Steve, and the funny thing is that it was Chinese demand that caused the oil spike of 2008. Remember how during the years prior to 2008 the globalist apologists were falling over themselves extolling the virtues of globalisation and free trade. "The NICE decade!!!" (Non Inflationary Continual Expansion)they trilled, "The Great Moderation!!!!" they screamed.Basically the globalists were full of themselves at how wonderful they were and how clever the policy of off-shoring all economic activity to China was.

The problem I have with all of discussion of energy resources is that it has so little to do with geological matters or independent market forces. All energy pricing seems to be artificial and subject to the whims of insiders.

Half the Democrats on earth moan about how the US uses up a disproportionate amount of the world's energy. They recommend therefore austerity if not outright poverty. There are those in the Obama administration who probably approve of US unemployment because it lowers our "carbon footprint" and restores "fairness" as we work our way down to the per capita GNP of Swaziland.

How else can we understand the burning of ethanol in our cars? Burning corn makes no sense but does enrich Archer Daniels Midland and a few others.

Jerry Brown will be governor again. The windmills that he subsidized his first time around still have yet to make any market sense. The "diminished expectations' Democrats are still waiting for the breakthrough in solar cell technology that we first heard about in the seventies.

Then there's oil, gas and coal. We have indeed used up most of the sweet light crude in Texas that helped the Brits win the Battle of Britain. But the bigger reason for domestic oil shortages is simply politics. Obviously Alaskan oil is political and now we have stopped drilling in the Gulf. Like ethanol, windmills, and solar panels our domestic oil production or lack of production has nothing to do with Mother nature and everything to do with our foolish ideas and the profits of insiders. In our last election both Obama and McCain were shown with windmills behind them. This policy was promoted by T. Boone Pickens to boost US dependence on his Natural Gas holdings.

If we need fuel for our cars we could gasify coal the way the Nazis did a half century ago. There is lots of coal in the US. But that solution has been cut off by the Global Warming campaign. Maybe those New Yorkers stuck in the airports this week will rethink some of their belief in Global Warming.

Nuclear energy is safer than any other form and produces less waste too. Yet it has been demonized by politicians and so that escape hatch has also been barred.

Saudi Arabia has most of the world's sweet light crude but the US has most of the world's less good oil. As much as 98% of all liquid hydrocarbons on earth may be in the continental US. Shale oil is super abundant. Makes you wonder doesn't it? Oil with rocks in it is obviously less preferable than the free flowing kind but why if there is a Peak Oil crisis isn't much being done?

Then again why should we respect the sovereignty of Saudi Arabia? If we wanted too we could just seize the oilfields. Oil was in fact discovered by the English and the US. It used to be considered ours or at least half of it. Between the wars Iran was split into three zones. The Russian in the north the British in the south and the native Persian in the middle. The British zone had most of the oil and was developed with the kind of homes you might see in an English village.

We have the military resources to retake the oil fields of Arabia and Iran and we certainly have the casus belli. But too many Americans and American interests are not interested in an energy independent America. That's why I don't bet on energy matters.

"Julian Simon won the bet to Ehrlich's considerable embarrassment.- I believe that Ehrlich was on the right track, though."

How many bets must be lost before this mindset is challenged? I've read variations of this statement, usually made when yet another Ehrlich proponent loses a bet, for years. This is always followed up with an excuse for the loss with a promise that it will be different next time.

So far in this thread we have:

*if Israel hadn't successfully sabotaged the Iranian nuclear program, and had to use more conventional means, leading to Persian Gulf retaliation, that $200/barrel price might well have been reached.

*...the world economy crashed back in 2008. Without the downturn $200 oil might well be a reality. Indeed, some observers (notably James Hamilton) argue that the 2008 crash was in part triggered by the oil price runup.

Simmons was wrong. Oil prices only need to rise enough to price enough demand out of the market to meet supply. That appears to be a "mere" 40% increase in only 5 years. But the cornucopians are also wrong in assuming that such increases are inconsequential. That's enough to kill the exurbs, which kills the housing market, which kills consumer spending, which kills corporate profits, which kills employment, all of which kill tax revenues. But hey, no big deal. Technology will save us.

Ok, cornucopians, you win. You're right, and I was wrong. You can open up that magical cornucopia any day now. Millions of 99ers, people living on fixed incomes, and bankrupt state & local governments would all appreciate it. What are you waiting for?

Even steady increases in oil prices lead to all sorts of economic havoc and general poverty.

Food, clothing, associated energy prices all go up. Leaving discretionary consumer spending at a minimum. Hollywood craters, as a result, but so too does the video game industry, piracy is rampant, so too home brewing/etc., casual street crime goes up (risk for min cash has changed), racial frictions increase over pie slicing AND being pushed together (exurbs lacking in NAMS become too expensive). Sales of new cars and trucks plummet, as does consumer electronics, clothing, etc. Nearly all available income gets devoted to daily living necessities, and inflation-protecting assets (gold, silver).

Its not as bad as the 2008 oil shock, but its bad. Much of it is self-inflicted: failing to intervene in Nigeria to produce oil there without the chaos and semi-revolution, failure to overthrow Iran (get its oil to market), failure to develop both onshore and offshore oil resources (no oil sands, fracking, etc.) or natural gas (NY State has forbid drilling). While utopian-idiot dreams of "green" tech ala solar/wind prevent say, coal gasification and other resources from acting as oil substitutes.

The global economy runs on cheap energy. Make it more expensive and everyone is poorer, the middle/working class considerably so.

in his last few years, he was almost always wrong about everything. everything he said about the BP situation in the gulf of mexico was fantastically inaccurate. quite a vivid imagination from that doomer.

there's no doubt oil will go over 100 dollars a barrel and stay there, though. i don't want to bother anybody with a long boring jody post, so i won't discuss the future of energy, all the what-if scenarios, where various technologies are at the moment, et cetera.

Come to think of it, I'd be curious to hear what Steve and the commenters here think of James Kunstler's Peak Oil ideas and arguments. (And yes I know that they aren't "his," exactly ... But he's a very colorful and smart packager, presenter, and arguer.)

Since American consumers are so indebted, as soon as they can't afford to commute, they will quickly lose their jobs and houses

Worth noting: Several hundred or thousand(?) zip codes in the USA were totally unaffected by the housing market collapse. Prices stayed steady. For every couple of these, there were one of these. Likewise these vs. these.

Where was unaffected? Non-violent urbanized areas with serious mass-transit; places you don't "need" to own a car.

My vast holding in the Vanguard Energy ETF ( VDE) is up 18.36 % year over year as of this this day last year. No, unfortunately, I bought it before then. But who knows how high VDE is gonna go this year!

Man, if I owned scores of millions of the stuff and lived in, say, Manhattan with all the other old stock Americans, I'd be sitting pretty.

My belief is that oil will stay at $100/barrel for quite some time, but that this floor will spur actual real alternatives, which means that a ceiling will be reached and eventually the price will trend a little below $100 in real dollors. IMHO.

Analysis of current economic conditions and policy« Stress | Main | Consequences of the Oil Shock of 2007-08 »

April 02, 2009

Causes of the Oil Shock of 2007-08...

My [ Hamilton's ] paper also has an extensive examination of an alternative explanation based on a speculative bubble in the price of oil. I will not attempt to reproduce much of that analysis here, but only note the bottom line: in order to reconcile a proposed speculative bubble story with the observed behavior of the physical quantities demanded, supplied, and going into inventories, it is necessary to postulate a very low price elasticity of demand through 2008:H1-- precisely the same conditions one would need in order to attribute the price moves entirely to fundamentals.

( Huh? Why not present or summarize more of that analysis here. -- DD )

...

Posted by: JDH at April 3, 2009 04:26 AM

I realize that it is blasphany to question accepted economic dogma but elasticity nothing more than a different way of measuring demand. It is good for econometrics, but it introduces error into economic thinking and real life policy making. ...

Note the professor's comment, "A short-run elasticity of 0.06 for crude petroleum demand could certainly be defended on the basis of estimates in the literature, though so could a higher or lower value. ... "

( In other words, Prof. Hamilton is appealing to the authority of the econ. literature, but why should we trust that? --DD )

1. It assumes sellers behave like commercial profit maximizers. But in fact the major sovereign sellers of crude oil are not--they behave politically to balance budgets and stabilize demand. So in the high price ranges we had a year ago, major producers were willing to sell the same amount of oil--or even more--at lower prices, and they actively tried to talk down prices because they feared a short-term collapse in demand followed by long-term shifts away from petroleum use (such as happened after 1982)....

2. Spot prices of OPEC oil are not set by negotiation between buyer and seller, as this analysis assumes. Instead, the price is set by long-term contract price formulas that are driven by crude oil futures prices. The report of the Oxford Institute for Energy Studies is here. http://www.oxfordenergy.org/pdfs/WPM31.pdf My summary of it is here. http://www.realitybase.org/journal/2008/7/4/international-crude-oil-markets-dont-function-like-textbook.html The futures market, I suggest, was responding to fundamentals of supply and demand--for futures contracts. The bulls dominated the bears in crude oil futures and drove up the prices--just as they did in other bubbles from dot-com stocks to residential real estate. These players counted on momentum to make money and were for the most part not hedging transactions in wet oil. When the momentum reversed, they all rushed for the door at once. Mark Thoma noted coordinated moves in prices of crude oil futures and other commodities despite the tiny likelihood that there were coordinated changes in fundamentals for all commodities. ...

Posted by: Roger Chittum at April 3, 2009 11:53 AM

There seem to have been two phenomena of oil price increases: the rapid rise to $140 in 2008 followed by a collapse, and a steady multi-year rise in real terms after 2002, which seems to be continuing. I'm impressed by the paper, but it seems necessary to distinguish between the two, they likely have very different causes and consequences

...

http://www.econbrowser.com/archives/2009/04/causes_of_the_o.html

I agree with the comments quoted above. I tend to think that speculation caused much of the 2008 oil price spike, although there is a long term secular trend of increasing oil supply constraints.

Establishmentarian profs such as Dr. Hamilton cling to the worldview that markets are always efficient, and that speculators are insignificant noise in their beautiful econometric models.

Re: Anonymous, Ehrlich was not on the "right track" anyone betting the long term price of commodities will increase is probably going to lose. When prices increase, the number of people looking for more commodities increases thusly. The amount of natural resources in the ground always greatly exceeds what experts assume can be found, the real limiting factor is usually price, at a high enough level, all kinds of resources can be found. Long term secular trends in the prices of virtually all major commodities is down especially on the longer time scales: decades, or a century, by the year 2000, oil had reached in inflation-adjusted terms it's lowest level in a very long time, maybe a half-century, it was simply overdue for a price increase in the 2000's.

"... what had happened is that the slump and deflation that occurred throughout the 70s and 80s (GDP was stagnant throughout that period, unemployment was massive"

Hey, Anonymous, you can't write this BS and expect everyone to believe you, since some of us were alive and awake during that time.

Short history: Inflation (not deflation!) got bad only in the period of the mid-1970's through 1980. It was stopped by Paul Volker (of the FED) raising interest rates drastically. Before that, it was a crazy price control scheme (early '70's) by Nixon, and then President Ford bought a whole lot of lapel buttons to help (yeah, plenty of room for "flair" on your lapels back in the '70's).

The 1980's were very much different from the 1970's due to control on inflation and then Reagan's lowering of tax rates. 1981 was the year disco died and the economy of the US was reborn (for a 25 year extended lifespan).

Unemployment went down after the recession of '81-'82, and inflation was (officially, anyway) low from the mid-80's to now.

Highest unemployment was around the 10 % mark during the early 80's recession, but I think average was 5-8 % during the 1970's period. The highest inflation rates were in the 1979-1980 period - almost up to 18%, and you couldn't get much lower than that percentage on a house loan for a while there. (House loans didn't come down below 10 % until 1990!)

The 1980's weren't anything like the 1970's economically, so don't spout off nonsense, please.

"I'd be curious to hear what Steve and the commenters here think of James Kunstler's Peak Oil ideas and arguments"

Peak oil is real, but JHK is a loony, along with all the other apocalypto gold-n-ammo hording libertarian types.

We could reduce our oil consumption by 50% just by switching back to 120hp cars, which are still the standard among middle-class Europeans and Japanese Somehow our economy managed just fine in 1990 before anyone drove SUVs and most cars had around 100-120HP. (A base 1989 Honda Accord had 89HP.)

There is also no shortage of cheap domestic natural gas, which already powers lots of buses and can run cars just fine too.

Cheap oil is nice but we'll do just fine without. Exurbs will also be OK given the growth in exurban office and industrial parks plus hospitals.

The first couple posts in the thread make an important point, here. If you are convinced of one of these bets, and have a reasonable amount of money you're willing to risk, you can actually bet with your own money, in established markets.

Now, the downside of this is that there are a lot of people who make such bets for a living, sometimes as speculators, sometimes trying to hedge their exposure to commodity prices of various kinds. They may be, and often are, wrong. But it seems unlikely you are going to be able to make better predictions than they can based on information that's commonly known.

However, if you are truly convinced that oil prices will top $200 by 2015, you can place a bet that will net you a tidy profit if you're right. But I wouldn't bet my eating money....

As best I can tell, Chinese demand drove the rising oil prices. But were most of the people predicting that we'd run out of oil any day now basing their prediction on China going crony-capitalist and industrializing? If not, their prediction was right by accident, not because of any deep insight of theirs.

China industrializing has some bad effects in the short term--more pollution, more CO2, higher oil prices. But it's also one of the best things to ever happen, in terms of human welfare, lifting millions of people from godawful third-world-peasant poverty to something like first-world living conditions. It's basically what happened to Europe and the US, a century or so behind.

Any bets you guys make, if it's for publicity, as Steve reckons for this case, you should bet in nominal dollars. However, if you care to win some money, I'd advise y'all to bet in 2010 dollars or oz. of gold.

It's kinda like "hey, I'll bet you a wheelbarrow full of 100's that we won't have any hyperinflation in America through 2013". I mean, it's a win-win for me.

Any takers, just in case? How 'bout some of you socialists - you guys ain't too good with math, logic, and observation, right? Bring it.

Mel Torme, You're the one with the slective memory.I well remember the damage the oil shock of 1980 did (oil rose to its highest price ever in real terms), the early 80s and the Volcker induced deflation were a terrible time. In fact economic activity and demand for oil slumped so far that oil scraped $5 dollars per barrel in 1986.Germany actually had negative inflation in that year.

"Mel Torme,You're the one with the slective memory.I well remember the damage the oil shock of 1980 did (oil rose to its highest price ever in real terms), the early 80s and the Volcker induced deflation were a terrible time.In fact economic activity and demand for oil slumped so far that oil scraped $5 dollars per barrel in 1986.Germany actually had negative inflation in that year."

Well, at least some facts here, but your last post was about 95 % wrong facts.

Your memory on oil prices (or your ability to read a graph) is much better. Oil went way up in 1973-1974 (Israel-Syria? Yom Kipper war), then again way up in 1979 (Iranian revolution and subsequent hostage crisis).

Due to Volcker (your spelling is better too ;-) taken the necessary step to stop the high inflation, the employment situation was tough for about 2 years, 81 and 82. However, contrary to your first post, inflation was well on the way down from it's super highs in the high/mid teen percentages by 1981.

The 1980's were good economic times in general, except for one thing. Due to congress's refusal to budge on their insistence on expanding all discretionary spending, with Reagan's military recovery/build-up, the Federal Gov't deficit started it's slow climb during that decade that continued (accelerating not until 2000's) through today.

I think you are right about 1979 oil being the highest ever price in REAL TERMS (even beating summer of 2008?) Course, I could just pull up a graph, I guess.

However, the oil glut of 1981 all the way through 1999 (with minor interruption in 90-91) was not due to bad economic times. If you think that, then I maintain that you both weren't alive then and never talk to anyone about recent history.

Yeah. Utterly destroyed the domestic "wildcatting" drilling industry. Which has NEVER fully recovered.

One of the reasons it costs so much today to do directional drilling in Bakken in ND is because those brand new $100,000 drilling rigs bought in 1979, 1980, after the oil crash in '82, were sold for SCRAP. But the interest still accrued on the purchase loans, at 22%.

No WAY anyone is anxious to order a bunch of new drilling rigs today after THAT.

Also, Volcker's 16% prime rate devastated the building industry. I know. My dad was a homebuilder. He saw it coming, sold his last house and retired. Others were decimated. People can't buy with home loans of 16%.

(Truthfully, though, it wasn't just Volcker's doing. Reagan asked the Saudis to massively increase production to drive down prices. Which they did by pumping saltwater to force the oil out faster, damaging Ghawar as a result, meaning far less total production over the life of the field. OOOOOPS.)

Since WWII, oil almost always goes for 15 barrels per ounce of gold. Even when it doesn't, as when the oil price soared in 2008, the anomaly is brief, and the 15/1 ratio soon returns. As I write, 8:35 pm PST on Dec. 30, 2010, it's $1,408.34 / $89.55 oil = 15.73 barrels of oil per ounce of gold.

So, the price of oil in dollars really depends on whether the Fed keeps inflating the dollar against gold, as it has since 9/11.

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